Transform family home to a rental property?
Member since 2019 · 20 posts · 3 votes
We've outgrown our family home, but instead of just selling it, we wanted to keep it & rent it long term. $200k + equity in California home. Hoping to transfer to LLC? Good idea? Thanks!
We've outgrown our family home, but instead of just selling it, we wanted to keep it & rent it long term. $200k + equity in California home. Hoping to transfer to LLC? Good idea? Thanks!
Katie is way more qualified to answer with respect to LLC and any tax consequences. I will answer with a different perspective.
Like a lot of RE investors, we started with our family home as our first rental property. It has always been our worst performing asset in terms of cash flow per equity. This is because it was purchased to be a good home for me and my family and not necessarily to be a good investment property. When looking for an investment property you do not have the same emotional ties and can be more analytical. You can purchase in areas that may not be areas that are great today but may improve significantly over the years. The primary criteria for the purchase is the expected return. My family likes a yard. A big yard. Most renters do not want to maintain someone else's yard and are not willing to pay for a larger yard. Some investors that are willing to pay for a larger yard and like the idea of a large yard in theory do not want to maintain the yard. There are many things that could make your home great for you but not appeal to many renters.
So when choosing to keep your ex-home, look at owner tax benefits that will be lost if you do not live in the home for a certain duration and look at if your investment dollars could perform better elsewhere (I think most people who convert their ex-home to a rental could have done better purchasing a different property).
So my ex-home is our worse performing property from an equity perspective. However, I purchased the home for $167K (full retail) and today it is worth ~$630K. It has done fabulous but my other purchases have done better and an investor should want to maximize their return.
Good luck
There are several considerations that can go into the analysis of whether you need an LLC or whether a large insurance policy will suffice. Will depend on several factors like the type of property, type of tenants, your risk tolerance, other assets you own, your estate planning, laws where the property is located, etc.
Any lawsuits would be limited to the assets of the LLC and not your personal assets (assuming you run the LLC appropriately and the corporate veil is not pierced). But, an LLC will not limit you from liability in total. You can still lose your investment in the LLC. If you're going the umbrella insurance route, make sure it will cover you for several things including just the routine slip and fall (like mold or earthquake). You'll also want to ensure you have a good property manager to look after the upkeep of the property if you are not there to notice anything deteriorating or which may need attention. Sometimes a good insurance policy is all you need.
This article goes into a lot of the considerations about whether to form an LLC or not: https://www.mmpph.com/wp-content/uploads/2019/04/May-2019-newsletter.pdf
Creating an LLC in California would cost you a minimum tax of $800 every year. You would have ongoing filing requirements with the State and would need to keep business records and documentation. If you have a mortgage, you also may want to look at any due on transfer clauses.
You also want to look at whether a pass-through entity helps your bottom line and your taxes. There is a new 20% pass through deduction you may qualify for that could help you, but not everyone qualifies. You should still be able to get this even if the properties are not in an LLC, if you qualify.
These are all things you will want to discuss with your attorney and CPA. If you need references for either of them in San Diego, let me know.
*This post does not create an attorney-client or CPA-Client relationship. The information contained in this post is not to be relied upon. Readers should seek professional advice.
@Katie Lepore
Thank you for taking the time.
Sell.
Not the greatest state to be a landlord, and you can take the $200k tax free today as opposed to paying $40k+ in state and federal income tax if you turn it in to a rental. If you wouldn’t buy it today to be a rental don’t keep it as a rental.
We've outgrown our family home, but instead of just selling it, we wanted to keep it & rent it long term. $200k + equity in California home. Hoping to transfer to LLC? Good idea? Thanks!
Katie is way more qualified to answer with respect to LLC and any tax consequences. I will answer with a different perspective.
Like a lot of RE investors, we started with our family home as our first rental property. It has always been our worst performing asset in terms of cash flow per equity. This is because it was purchased to be a good home for me and my family and not necessarily to be a good investment property. When looking for an investment property you do not have the same emotional ties and can be more analytical. You can purchase in areas that may not be areas that are great today but may improve significantly over the years. The primary criteria for the purchase is the expected return. My family likes a yard. A big yard. Most renters do not want to maintain someone else's yard and are not willing to pay for a larger yard. Some investors that are willing to pay for a larger yard and like the idea of a large yard in theory do not want to maintain the yard. There are many things that could make your home great for you but not appeal to many renters.
So when choosing to keep your ex-home, look at owner tax benefits that will be lost if you do not live in the home for a certain duration and look at if your investment dollars could perform better elsewhere (I think most people who convert their ex-home to a rental could have done better purchasing a different property).
So my ex-home is our worse performing property from an equity perspective. However, I purchased the home for $167K (full retail) and today it is worth ~$630K. It has done fabulous but my other purchases have done better and an investor should want to maximize their return.
Good luck
@Bill Brandt
Thank you for taking the time. I’d like to learn more about california on terms of landlord friendly or not. Thanks for your input.
@Dan Heuschele
Thank you for taking the time. We are doing our diligence and hoping to make the best decision. Fact is, if we hadn’t outgrown it, we would stay. I would be happy to rent it cash flow neutral and hang on to it for 30+ years building equity.
Heres a few facts about the home.
-brand new elementary school built across the street.
-HOA fees $118 but include in home high speed internet, And clubhouse access with 4 pools and indoor spa, full huge weight/workout room, basketball court, tennis courts etc.
-creek across the street and jogging trails everywhere.
-4 bedroom/ 3 bath 2300 sq feet.
I’m not sure if these are things conducive for renters or a big sales price. But definitely an asset I would have a hard time just selling out of. Your thoughts?
Would love to hear more advice, takes, trials, tribulations, etc.
@Dan Heuschele
Thank you for taking the time. We are doing our diligence and hoping to make the best decision. Fact is, if we hadn’t outgrown it, we would stay. I would be happy to rent it cash flow neutral and hang on to it for 30+ years building equity.
Heres a few facts about the home.
-brand new elementary school built across the street.
-HOA fees $118 but include in home high speed internet, And clubhouse access with 4 pools and indoor spa, full huge weight/workout room, basketball court, tennis courts etc.
-creek across the street and jogging trails everywhere.
-4 bedroom/ 3 bath 2300 sq feet.
I’m not sure if these are things conducive for renters or a big sales price. But definitely an asset I would have a hard time just selling out of. Your thoughts?
Would love to hear more advice, takes, trials, tribulations, etc.
@Bill B. is correct that the legislation is not LL friendly but due to low vacancy it is not much of an issue if you screen well. The rent control does not apply to SFR owned by individuals (so does not apply here). Getting rid of a problem tenant can be a nightmare, but in practice it is rare and it is rare because an evicted tenant will find it difficult to ever find another quality rental. So evictions in this state occur less than virtually any other state for both the reason that the tenant does not want an eviction on their history and because the LL does not want the hassle of an eviction.
On to your unit …
My first concern is the HOA fees. That seems like a lot of items for that fee. Is it sustainable? What happens when the pools need cap expenses? The basketball court needs to be replaced? Etc? Do you think they have allocated for building a cap expense reserve? if not (which I suspect), what is going to happen when the pool needs to be resurfaced, the heater goes out, that basketball court needs to be repoured, the weight room equipment needs replacing, etc. I fear it is like the school distract that spends all of the money allocated on current expenses and hopes to convince the voters of supporting a school bond for cap expenses. It reflects poor management and a private business that did this would likely go bankrupt. Cap expense is a certainty.
Second, it sounds like a nice home. Nice homes have worse rent to value ratio than C class homes. Have you run the numbers using the 50% rule? My expectation is this will be huge cash negative. The 50% rule is conservative in high rent areas, but you want your projections to be conservative. If you are self managing, the 50% rule in effect becomes 40% but realize that there is some effort being a PM even to class A/B properties. It is important to have a ROI projection and use it in your decision. I expect the cash flow using the 50% rule will be much worse than you are anticipating. This alone may sway your opinion.
Third, No one has a crystal ball to know how the appreciation will be going forward. I am in the middle ground with what I am expecting near term. I believe the most likely scenario is the next few years will be flattish (i.e. appreciation near the inflation rate). Note many people are expecting the market to fall. Some people are expecting outstanding gains similar to 2012 to 2017. For long term I am still very optimistic on California appreciation. My primary area is San Diego. San Diego has outstanding long term appreciation for more than 60 years. I expect in the long term, it will continue to appreciate more than inflation. Assuming I am correct on the short term appreciation (which I may not be) there is no big incentive to start now (versus a few years ago if you did not get in, you lost out).
Good luck
@Dan Heuschele
Thanks for your input. HOA sends us annual budgets but im not sure how easy it is to fudge city GAAP numbers. Perhaps an accountant could see if they are in good financial shape?
-Our payment is 1600 @ 4.25% tax & ins (perhaps time for refi?)
-rent is getting around 22-2600 a month from local comps
Currently i don’t know the formula for 50% rule, I’ll do some digging.
Thank you.
Hi @Dayne Delano, Welcome to the Forums. Depending on the Elementary School and area you speaking of, it could be a good rental property, and/or a good time to sell. I would need more details. Also being a 4/3 2300sqft property it may work well for one of my househack clients, especially with those amenities and low HOA.
I do agree with @Dan H. your HOA seems low for what it includes, I assuming it doesn't include water, how about trash? I would ask to confirm how the HOA is doing with reserves.
Depending on the variables, you could get a better rate if you refi, and the better rates are for owner occupied loans, therefore you agree you have the intent to live on the property, which if you did decide to rent and buy elsewhere, you may run into issues if within the first year. If you are considering doing a HELOC it best to do so before you turn it into a rental.
@Kenneth Donaghy
Hi Kenneth,
Thanks for your input. Water/Trash is separate. There is also separate mello roos bonds here and it CAN be paid off. We just chose not to for the time being. I believe mello roos is around 28,000. We’ve been here since it was built by Centex in 2008. We’ve had alot of interest on our property in terms of listing it. Its a popular street and when one house goes up for sale, we get alot of knocks from the listing realtor. But I am totally in it for the long game, not so much this house, but just looking at all the options and making the best pragmatic course of action. You guys are a huge help.
There was a poster above who mentioned if I converted it to a Rental I would have a ~40k tax bill or something along those lines. If i’m in it for the long term, I would be willing to if it was the best course of action. Your thoughts?
Thank you.
@Dayne Delano regarding Tax Liabilities its best to consult a CPA and @Katie L. has the best local recommendations for CPAs.
I do know there are tax incentives if you have lived in the property 2 of the last 5 before the sale of the property.
Again, a good CPA is whom you should speak with.
As indicated earlier, I am not a tax professional. I suggest you verify all information you get on public forums like BP that could be financially costly.
Money an owner makes on the sale of his or her principal residence is excluded from being taxed up to $250,000 in gain for a single person and $500,000 for married couples filing taxes jointly. There is a requirement that you live in the home for at least 2 of the last 5 years. So if you convert this property to a rental for the long term, you will loose this benefit.
For rental property, I never plan on paying a tax from the increase in value under the current rules. There are a couple of options: 1) Never sell, when I die the value gets readjusted to current market for the heirs. If they sell immediately, the value increase has vanished and the tax is never collected. 2) 1031 exchange the property. Lets say for example that for some reason it is too cumbersome to own 20 properties even with the use of the PM. I can 1031 exchange it to something that is more passive such as NNN or large multifamily with onsite PM.
You will only get hit with the tax if you sell without 1031 exchanging or if the rules change. So the post that indicated the tax cost was indicating the tax cost assuming that you at some point had to pay the taxes (under current rules, never pay those taxes).
Good luck
@Dan Heuschele
Thank you for your input.
@Dan Heuschele
Just a hypothetical 50% rule breakdown (please help me if something looks out of wack, i’m both a newbie and using a rental cash flow calculator, I’m sure somethings off)
Monthly estimated Rent Fee: $2400
Mortgage Principal/interest: $888.29
Monthly taxes: $592.71 (high because of Mello Roos bond, I could possibly refinance and bring this cost way down paying it off using equity in home)
Monthly insurance: $77.33 (would assume would rise substantially with landlord policy)
Initial monthly cashflow: $841.67
Maintenance costs: $200
Vacancy cost: $65
Property management: $104
H.O.A. : 118
Final monthly cashflow: $360 (not my math lol)
Just a really rough figure to see how it looks to you guys.
And a few questions, typically does the electric bill & utilities get paid through the landlord or directly to companies?
Thank you.
@Dan Heuschele
Just a hypothetical 50% rule breakdown (please help me if something looks out of wack, i’m both a newbie and using a rental cash flow calculator, I’m sure somethings off)
Monthly estimated Rent Fee: $2400
Mortgage Principal/interest: $888.29
Monthly taxes: $592.71 (high because of Mello Roos bond, I could possibly refinance and bring this cost way down paying it off using equity in home)
Monthly insurance: $77.33 (would assume would rise substantially with landlord policy)
Initial monthly cashflow: $841.67
Maintenance costs: $200
Vacancy cost: $65
Property management: $104
H.O.A. : 118
Final monthly cashflow: $360 (not my math lol)
Just a really rough figure to see how it looks to you guys.
And a few questions, typically does the electric bill & utilities get paid through the landlord or directly to companies?
Thank you.
Now quick 50% rule calculation to see how the numbers compare:
$2400/2 - $888 = $312.
The 50% rule can provide a quick cash flow estimate. It is not as accurate as a more detailed estimate if the detailed estimate uses good estimates. However, in your estimate I see nothing allocated for cap expense. If the maintenance is to include the cap ex, it is too low. I also would have allocated 10% for PM, but that is not a big difference.
The numbers from both calculations are pretty close to each other showing the ease and value of the 50% rule.
On single family in our area the utilities are in the name of the tenant and paid for by the tenant. However, we are setup with the utility so that it automatically reverts to us when tenant terminates. This saves hook up fees and I highly recommend you do this.
good luck
@Dayne Delano
Getting your equity out tax free will cost you 3-6% in selling cost..much less if fsbo. And buying a replacement more suitable for investment will cost %20 down plus loan costs plus time and stress. And usually a little fix up. So that seems almost a wash with just keeping the one you have. Your house as a rental will suffer more wear and tear than if you lived there so if you later change your mind and decide to sell you will have a bit of a run down property...but you get to depreciate each year. Of course you pay depreciation all back with interest when you sell....not really interest but the rate is 25% so pretty high if you are in a lower tax bracket.
@Marian Smith
Thanks for your take Marian.
I’m willing to accept the deterioration over time, I have no doubt it will be in much worse condition over a long rental tenure. Being a newer home (2008) and a Tile roof. I believe it is built for the long run, along with perhaps some pragmatic and cognizant changes to the home “over-time” like lifeproof/waterproof flooring throughout, and a low maintenance perhaps water free front and rear landscape. Things conducive for a more wear resistant, less trouble down-the-road, rental atmosphere.
@John Mocker
Thank you John for your insight
@Dan Heuschele
So Refi rates look pretty attractive. I plan to refinance & beef up my figures below thanks to Dans cash flow insights. If you have a moment, please shoot holes (critique) my cashflow numbers. Where do I/should I add/subtract my monthly figures.
$608 Property tax (high because county bonds)
$83 landlord Insurance policy
$245 Property Management @ 10% Rent
$590 Mortgage
$118 H.O.A
$245 vacancy fund @ 10% Rent
$245 repair fund @ 10% Rent (both capital & maintenance)
2294 Total expenses
$2450 proposed Rent
——————————-
$156/mo estimated cash flow
Bad math on my part, apologies.
2134 total expenses
2450 proposed Rent
——————————
$316 monthly cash flow
@Dayne Delano I have read through this thread and I find a lot of useful information shared here. Maybe I am missing something but for me, there are two aspects to look at:
1. Is it a good time for you to get a new home with great rates to allow your family more space and comfort? If the answer is yes, you could determine if you like to leverage the cheap money now and get as much mortgage on your own owner-occupied property as possible. I would opt for that if I were you. It is something for you to decide. You could also opt to lower your payments and have more disposable money by having a larger downpayment from the sale of your current property and throw in the equity you would gain as part of your downpayment.
2. If you decide to not exchange your current house for a new one but use it as a bank for you (temporarily by utilizing the accumulated equity, possibly minus a part for the downpayment of your new home), I recommend looking for performance in suitable markets. You mentioned that your market has issues in the legal aspect, costs, others pointed to HOA possibly being low. I recently found myself in a similar situation. I sold a property, got about $250K in equity, did a 1031 exchange to avoid negative tax implications, and ended up with 8 properties with the net cash flow of $2000/month. I agree with Dan that your cost and reserve - estimates are pretty low in some parts and I always use the same values he suggested. I might be simplifying too much but if your cash flow is $360 or even $400/month and you could have $1500 - $2000/month, I think the performance evaluation is very important.
Several people have asked me how I have executed my sales and purchases and maintained all the timelines for the 1031 exchange, etc. I am mentoring people who like to do the same as I am in my strategy and my network. I prefer the 1% rule over the 50% rule but both are valuable starting points to check a property.
If you like to discuss further we can have a free strategy session and talk about what I did, what your goals are, and maybe how I can help you. Just PM me if you are interested
Thank you @Axel Meierhoefer for your insight.
Truth is ...happy wife happy life, Right? If my wife got her way she would choose to roll the equity to a bigger home for the fam. Perhaps shes right.
I have 5 kiddos I hope to get through college [and life] 4 of them girls I’d imagine ill have a wedding or two down the road. Just trying to be pragmatic and play the LONG game [If needed] when it comes to growing the family cash pile.
@Dayne Delano I don't see it as only black and white. Its a balance and one cool goal could be to have a property for each of the kids as a college fund. If you finance those for 30 years but pay on a flexible plan 15 - 18 years depending on their age they would each have an asset in case student loans have not been abolished by then - and if they are, you have a great retirement income and can probably brag about economic and financial freedom.
@Dayne Delano
One way to structure it is to sell your property in installment at top market value to a newly created Corp.
You will then realize the full sale on your taxes but also get the section 121 exclusion. Your Corp will then be able to get the full depreciation.
This strategy has some drawbacks but also some big benefits. You need to weight the pro and con with a good cpa and real estate attorney.